Comment on the upcoming data and forecasts. Paper Next auction Last Offer Yield on the prev Prev auction

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1 January 13, 2017 Polish Weekly Review Department of Economic Analysis (research) Ernest Pytlarczyk, PhD, CFA chief economist tel Marcin Mazurek, PhD senior analyst tel Piotr Bartkiewicz analyst tel Karol Klimas analyst tel Department of Financial Markets (business contacts) Wojciech Dunaj head of interest rates trading tel Marcin Turkiewicz head of fx trading tel Department of Financial Markets Sales (business contacts) Inga Gaszkowska-Gebska institutional sales tel Jacek Jurczyński head of treasury sales tel mbank S.A. 18 Senatorska St Warszawa P. O. BOX 728 tel fax Table of contents Our view in a nutshell page 2 Economics page 3 Inflation is accelerating, but so far due to fuel prices, food prices and base effects The MPC keeps rates unchanged, explicitly allowing real rates to turn negative Fixed income page 4 Range trading ahead of rating decisions Money market page 5 MPC FX market page 6 Spot Consolidation Options EUR/PLN vols melting continues Comment on the upcoming data and forecasts Week begins on Monday with the release of core inflation data - based on last Friday s GUS data, we estimate it at 0.0% y/y. On Wednesday the CSO will publish monthly labor market statistics. While we are in agreement with market consensus regarding the slight slowdown in employment (high statistical base from last year is enough), our forecast of wage growth is more pessimistic as we see base and calendar effects dragging down wage growth. On Thursday the CSO will release industry and trade data, with interesting developments. Due to base (both an a monthly and yearly basis) and calendar (difference in working days dropped from 0 to -1 y/y) effects, industrial output growth is set to stagnate annually. The accompanying PPI data will surprise to the upside as market consensus is probably underestimating the full impact of energy price spike on producer prices. Finally, the abovementioned calendar and base effects will not deter retail sales from accelerating we believe that the impact of 500+ programme on Christmas-related spending will prove to be decisive. Week ends with the release of monthly consumer and business sentiment data from the CSO (for January). Polish data to watch: January 16th to January 20th Publication Date Period mbank Consensus Prior Core CPI y/y (%) Dec Average gross wage y/y (%) Dec Employment y/y (%) Dec Sold industrial output y/y (%) Dec PPI y/y %) Dec Retail sales y/y (%) Dec Consumer confidence Jan Business confidence Jan Treasury bonds and bills auctions Paper Next auction Last Offer Yield on the prev Prev auction auction (%) (32/37/52) Week T-bills 1/16/ /9/2017 2Y T-bond OK1019 1/23/ /5/2017 5Y T-bond PS0422 1/23/ /5/ Y T-bond DS0727 1/23/ /5/ Y T-bond WS /7/2016 Reality vs analysts expectations (surprise index* for Poland) Comment Unchanged as CPI was not revised from the flash estimate. Next week brings several opportunities for surprises: wages, industrial output, retail sales and PPI. * Surprise index presents in a synthetic way how the market was surprised by macroeconomic releases (it is constructed on daily basis as weighted average of differences between selected releases and Bloomberg forecast consensus). 1

2 Fundamentals Our view in a nutshell 2016 unfolded as the year of record divergence between investment growth and consumption growth. The latter is the only engine of growth. GDP growth will likely bottom at ca. 2% y/y in Q4, when base effects reach their peaks. Momentum is positive, growth likely picked up on a q/q basis in Q4 already. Next year, growth will accelerate to the average of %, as investment returns to growth. It will, however, come no sooner than in mid-year and the effects of 500+ programme will begin to fade by then. The period of lower growth is not over. Polish deflation has ended. During the next two quarters inflation will be boosted by statistical base effects, weak PLN and commodity price spike (headline inflation to reach 2.0% at the turn of Q1 and Q2). We are still skeptical of genuine inflationary pressures in the Polish economy, though. The fate of inflation in the second half of next year, absent a sustained increase in commodity prices, is by no means certain. Rising inflation will prove to be a fertile ground for rate hike bets. It is very unlikely that these will materialize this year, though. We see the MPC s reaction function as symmetrical see the Glapinski s comments on allowing real rates to run negative. Financial markets Global reflation trades weakened the Zloty by raising risk-free rates and encouraging capital outflows from EM assets. Due to the weakness in exports and country risks still present, we expect Zloty to remain weak for the time being. The prevailing event risk for PL assets, the CHF conversion, moved to the background, as its details are unlikely to be announced soon. Stronger dollar and more hawkish Fed hold in check any strengthening of Polish zloty. However, inflows to Polish equity market are shifting the balance towards stronger PLN. mbank forecasts F 2017 F GDP y/y (%) CPI Inflation y/y (average %) Current account (%GDP) Unemployment rate (end of period %) Repo rate (end of period %) Q1 Q2 Q3 F Q4 F Q1 F Q2 F Q3 F Q4 F GDP y/y (%) Individual consumption y/y (%) Public Consumption y/y (%) Investment y/y (%) Inflation rate (% average) Unemployment rate (% eop) NBP repo rate (% eop) Wibor 3M (% eop) Y Polish bond yields (% eop) Y Polish bond yields (% eop) EUR/PLN (eop) USD/PLN (eop) F - forecast 2

3 Economics Inflation is accelerating, but so far due to fuel prices, food prices and base effects Base effects in fuel prices coupled with strong m/m growth in the same category (5.3% in December), as well as higher-thanusual increase in food prices (1.2% m/m) lifted CPI to 0.8% y/y in December. The only core category with non-zero growth was transport goods and services (+2.9% m/m). Elsewhere prices remained flat and core inflation probably ticked up to 0.0% y/y. As we repeatedly claimed, the momentum in core prices is no longer negative, but slightly positive (with emphasis on slightly ). There are no signs of broad-based price growth or second-round effects from food and fuel price spike. The MPC keeps rates unchanged, explicitly allowing real rates to turn negative The MPC kept rates on hold during its January meeting, as widely expected. The tone of its statement was also unchanged current rate level is conductive to keeping the Polish economy on the sustainable growth path and maintaining macroeconomic balance. During the conference, the NBP governor treated the risks for inflation as balanced and symmetric. Before the last meeting, the MPC had waited the period of deflation and lower growth out, remaining unwavering in its optimism. Now, that data turned positive, the Council does not suggest that rates should be changed. Recent uptick in inflation is seen as exogenous and the tightening of labor market is welcome, not worrying. Governor Glapinski reiterated his view that, by holding nominal rates constant in the face of higher inflation, the NBP will allow real rates to drift below zero and stimulate the economy. These factors lead us to assess that the conference had a dovish tone. The MPC evidently wants to see through the coming uptick in inflation and refuses to fuel tightening expectations. In the coming months inflation will continue to accelerate due to base effects and commodity price increases we expect it to top at 2% in 3-4 months. The move is of course part of a global trend (that includes surprises as well as actual releases), but key question remain: will inflation continue to accelerate in the second half of the year or at least maintain its elevated growth rates? To remind our Readers: after Spring, statistical base effects are unfavorable, no upward pressure in core categories, oil prices likely won t grow beyond 55-60$ per barrel. 3

4 Fixed income Range trading ahead of rating decisions On Friday evening Moody s and Fitch will announce their rating decisions. We don t expect any changes. Market is dealing in a range: PS and DS The curve has slightly steepened, the PS0721/DS0726 spread moved from 73 to 78bps. Asset swaps currently are: PS0721/5y at 42bps and DS0726/10y at 64bps. On Monday, the Ministry of Finance will offer 32 weeks T-bills on an auction, we are expecting their rate at 1,55 4

5 Money market MPC As we signalled last week, Polish monetary policy comes to a new reality, where deflation is not a threat anymore. First remarks from the NBP governor are that stabilizing rates is still warranted. Market reacted very optimistically and 2y bonds rallied, reaching levels last seen before the latest CPI reading. We would be very cautious adding to our portfolio at this point. Analysts predict that CPI can reach 2% as soon as first quarter, while governor Glapinski in his interview signaled CPI only gradually moving to the lower band at 1.5%. If analysts predictions materialize, bonds may offer more attractive yields again. At today s OMO banks bought 80 bn of NBP bills. That should more or less square the market. Cash might be a touch higher than in the previous week. Ref rate vs Polonia averages: 30 day 29 bp 90 day 19 bp 5

6 Forex Spot Consolidation Last week was an extremely quiet one for EUR/PLN and are the respective low and high of the week. It clearly shows that there is actually no real interest in Zloty at these levels, and that flows are balanced. USD/PLN was much more volatile, as the USD shock absorber ( being the range). Ironically, the main event for PLN this week, will be seen today (Friday evening), when the fate of Poland s ratings will be decided, outside of PLN trading hours. The majority expects no change in rating, which would be PLN-positive. Our typical rangy approach assumes the current range is , and we will try to play that range. EUR/PLN vols melting continues The diminishing realized volatility, and tic stronger PLN are taking vols lower. 1 month EUR/PLN ATM mid is 6.1% (0.2% lower), 3 months EUR/PLN is at 6.7% (0.1% lower) and, finally, 1 year is fixing at 7.7% (unchanged). The currency spread (difference of USD/PLN minus EUR/PLN) was also better offered due to the falling EUR/USD vols. Skew is roughly unchanged. Short-term forecasts Main supports / resistances: EUR/PLN: 4.34 / 4.46 USD/PLN: 4.00 / 4.30 Spot Position: None. We would like to buy EUR/PLN at , we are ready to add at with a stop at 4.31 and hopes to revisit With higher core market yields, the low yielding Zloty is exposed to underperformance. Being Poles and living in Warsaw, we are also exposed to the constant noise from Polish political front. It is not really encouraging, and it creates the impression of a political crisis. As a result, we are more keen to fish at the level which seems to be a bottom of the current range rather than fade spikes. Options Vol We are short 3 month / long 9 month EUR/PLN. We have sold 3 month EUR/PLN ATM against our long in backend Vol, in Vega neutral terms. It is a positive Theta / slightly short Gamma structure. It expresses our general view, that even though higher vols can be seen due to rising yields, it will be a slow process. 6

7 Market prices update Money market rates (mid close) FRA rates (mid close) Date FXSW 3M WIBOR 3M FXSW 6M WIBOR 6M FXSW 1Y WIBOR 1Y 1x4 3x6 6x9 9x12 12x15 6x12 1/6/ /9/ /10/ /11/ /12/ Last primary market rates Paper Au. date Maturity Avg. price Avg. yield Supply Demand Sold 32W TB 3/14/ /30/ OK0419 1/5/2017 4/25/ PS0422 1/5/2017 4/25/ DS0727 1/5/2017 7/25/ Fixed income market rates (closing mid-market levels) Date 1Y WIBOR 1Y T-bill 2Y IRS OK0715 5Y IRS PS Y IRS DS1023 1/6/ /9/ /10/ /11/ /12/ EUR/PLN 0-delta stradle 25-delta RR 25-delta FLY Date 1M 3M 6M 1Y 1M 1Y 1Y 1/6/ /9/ /10/ /11/ /12/ PLN Spot performance Date EURPLN USDPLN CHFPLN JPYPLN HUFPLN CZKPLN 1/6/ /9/ /10/ /11/ /12/ Disclaimer Distribution and use of this publication The review note is based on the information available to the public. This review creates exclusively a marketing information as defined in Paragraph 9 Section 1 of the Decree of Minister of Finance dated November 20, 2009 on procedures and conditions to be followed by investment firms and banks mentioned in Article 70 Section 2 of Law on Trading in Financial Instruments dated July 29, 2005 as well as by custody banks. This review note is provided to you for information purposes only and is not intended as advice on any particular matter or as recommendation, offer or solicitation for purchase of sale of any financial instrument and should not be taken as such. mbank SA, its directors, officers, executives, managers, servants or agents expressly disclaim all liability to any person in respect of any-thing, and in respect of the consequences of anything, done or omitted to be done, wholly or partly, in reliance upon the whole or any part of the contents of this review note. The opinions and estimates contained herein reflect the current judgment of the author(s) on the date of this document and are subject to change without notice. The opinions pointed in review do not necessarily correspond to the opinions of mbank SA. The past performance of financial instruments is not indicative of future results. No assurance can be given that any financial instrument or issuer described herein would yield favourable investment results. mbank and/or its principals or employees may have a long or short position or may transact in the financial instrument(s) and/or securities referred to herein or may trade in such financial instruments with other customers on a principal basis. No client or other reader should act or refrain from acting on the basis on any matter contained in it without taking specific independent professional advice on the particular facts and circumstances in issue. Copyright protection exists in this publication and it may not be, even partially, reproduced of distributed without the prior written agreement with mbank SA. mbank All rights reserved. 7